Kezia Farnham

Senior Manager

Internal controls for nonprofit organizations

Internal controls are ubiquitous in the corporate world. They’re the checks and balances that help businesses guard their financial assets against misuse and/or mismanagement. But corporations aren’t the only entities that benefit from sound financial practices. Internal controls for nonprofit organizations are equally critical.

While it’s true that nonprofit organizations have to manage money differently, money is still frequently changing hands. From accepting donations to funding the nonprofit’s activities and everything in between, nonprofits must effectively manage their funds. To help you do that, this article will explain:

• What internal controls for nonprofits are, and why they’re beneficial
• Basic internal controls to get started with
• Examples of internal controls common across nonprofits
• Best practices for implementing an internal control system
  

What are internal controls for nonprofits?

Internal controls for nonprofits are much like the internal controls of for-profit organizations. In both cases, internal controls are processes that employees and/or third parties will follow to safeguard the organization’s assets.

Requiring staff to log off their computers any time they leave their desk is a control, but so is requiring approval for all purchases. These may seem simple, but getting internal controls wrong can expose nonprofits to breaches, misappropriation of funds and costly regulatory action.

How can an effective internal control system be beneficial to a nonprofit organization?

An effective internal control system is one of the best tools nonprofits have to secure two of their most important resources: finances and their reputation. Protecting both is key to a nonprofit’s longevity, but doing so can be difficult without successful internal controls.

Internal controls for nonprofits have numerous benefits, including:

• Transparency: Internal controls empower nonprofit boards to gain greater visibility into the organization’s finances, then offer that transparency to donors. This is a key way to retain donors, 57% of whom enroll in recurring giving programs.
• Regulatory compliance: Nonprofits must follow numerous comprehensive regulations, from the IRS’s strict 501(c)(3) status to frameworks like the Financial Accounting Standards Board. Internal controls are a valuable way to prove compliance.
• Reputation: Nonprofits with positive reputations are more likely to attract donors. Internal controls for nonprofit organizations assure donors that the organization is financially responsible and committed to its mission — something donors look for in a nonprofit.

Basic internal controls for nonprofits

As simple as internal controls can be, there are many different structures at play in any internal control system. Basic internal controls for nonprofits can dictate anything from how to properly make a purchase using nonprofit funds to how to handle cash. But no matter what the specific controls are, they should account for two different factors: types and components.

They include preventative, corrective and detective controls, which means that even the most basic internal controls should either prevent risk, correct risk, or detect it.

Nonprofits should also consider these five components of internal controls, which describe the environment controls will operate and the factors that basic controls will have to incorporate — or overcome — to mitigate financial risk successfully.

Examples of financial internal controls for nonprofits

Internal controls aren’t always the same across nonprofits. But certain controls make great examples for nonprofits seeking enhanced financial management. These are:

1. Cash transfer internal controls: If a donor transfers cash to the nonprofit, the nonprofit should keep thorough records about the transaction date, the donor, the amount and what the donation is for.
2. Segregation of duties: This control requires that multiple people are involved in each transaction. For example, the person approving the purchase should be someone other than the person making the purchase.
3. Donation procedures: If you’re accepting cash donations at an event, one staff member should collect donations, a second staff member should document and validate the donations, and a third staff member should deposit the donations.
4. Authorize reimbursements: Nonprofits need to document all expenses thoroughly. An internal control for this is to require pre-approval for any transaction that will later be reimbursed.
5. Operating budgets: A budget is a crucial internal control for nonprofit organizations. The organization should have an overarching budget, delineating individual budgets for different departments. All decisions should tie back to the budget, and the expenses and results should be tracked.
6. Independent reviews: Nonprofits should periodically review all third parties that receive payments from the nonprofit to validate the identity of the third party and that all fees are used as intended.
   

Internal control best practices for nonprofits

Internal controls don’t exist in a vacuum. They’re the product of a deep understanding of how your nonprofit functions concerning finances. That means that internal control best practices for nonprofits and their boards aren’t just about money and operations. Nonprofits can operate more securely by:

1. Analyzing your nonprofit’s finances: How does money need to move through your nonprofit to allow you to achieve your mission? You’ll likely need to accept and manage donations, run payroll, pay vendors and more. Internal controls for nonprofits should consider how to add safeguards to each of these critical processes.
2. Following an internal controls framework: There are regulatory bodies that have already recommended accounting practices nonprofits should follow. Consider implementing the COSO Framework and/or following the Generally Accepted Accounting Principles.
3. Documenting your internal controls: Even the best controls can fall flat if they are unclear. Create thorough documentation for all controls, both to prove your compliance with regulations and to give employees a guide for all financial activities.
4. Conducting an internal controls audit: How will you know if employees are actually enacting all controls? Periodically audit your financial processes to verify whether your internal controls are successful and, if not, how you can adapt them to be more effective.
5. Automating controls: The larger the nonprofit, the more complicated it can be to manage internal controls manually. Automating internal controls can put much of internal controls management on autopilot, freeing up your staff to focus on more strategic tasks that further your mission.
6. Leveraging technology: Because nonprofit governance is complex, it can easily detract from more meaningful, mission-based work. Nonprofit management solutions create greater efficiency, security and control, enabling change and effective nonprofit internal controls.

Unlock more strategic and secure nonprofit operations

Internal controls for nonprofit organizations are one step toward more effective and meaningful nonprofit operations. But what does it look like to put these basic controls and processes into practice?

UnitingCare, one of Australia’s largest nonprofit health, aged care, disability, and community service providers, felt they could more successfully serve their community if they could get visibility into all operating systems simultaneously.

They worked with Diligent to automate processes, connect data, and drive greater impact in their community.

Learn how Diligent can help you.